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The Reserve Bank was expected to ease rates for the first time in three years. Today's rate action by RBI, to cut the LAF Repo Rate by 50 bps to 8.00 per cent, came in as a surprise to the market. RBI has in a way frontloaded the rate cuts for this year, since the monetary transmission takes some time to sink in.
Despite giving a higher than expected easing in policy rates, the RBI remains geared towards containing any kind of sustained build-up in inflationary pressures. The developments on the fiscal deficit and current account deficit would matter greatly for deciding the path of monetary policy. Further, to tackle the liquidity issues, the RBI raised the borrowing limit under the marginal standing facility. This ensured that primary liquidity is not infused, which could lead to inflation.
FALL IN YIELDS
The 10 year bonds moved sharply from the day's high of 8.51 per cent to 8.22 per cent on the announcement of 50 bps cut in repo rate and thereafter again increased to around 8.35 per cent. The 3 month CD rates dropped sharply by 30 bps in line with the rate cut.
It is expected that this rate cut will help in reducing the funding costs for Government. However, considering the large supply pressure, the yields will have an upward bias once the Rs.33000 crore redemptions in the first week of May are over. The yields will remain low only if there is sufficient liquidity provided to the market either by way of CRR cuts or by OMOs.
FII INTEREST
The rate cut will assist in creating an environment for investment-led growth. This is positive for the economy and is reflected by the jump of over 220 points in BSE Sensex. The rebound in the equity market, particularly the rate sensitive sectors, is expected to draw the FII investor's interest. The foreign exchange flows from this segment will enable the USD/INR to hold its level in the near future.
The cut in the repo rate will be transmitted to the economy mainly through reduction in the deposit rates and lending rates by the banking system. It is expected that the deposit rate would be reduced initially, and thereafter the lending rates reduction will follow. The rate cut is expected to stimulate growth and the additional MSF limit will provide liquidity without creating any inflationary pressure.
(The author is Chief General Manager & Head Treasury, IDBI Bank.)
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